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Italy Notes Surge as ECB Allots 3-Year Cash; Bunds Fall

Italian and Spanish two-year notes jumped as the European Central Bank lent financial institutions more three-year cash than economists predicted, fueling bets the extraordinary loans will be used to buy the nations’ debt.

French two-year rates slid to a euro-era record, posting their third monthly drop. Italian notes yielded the least in 15 months as the ECB agreed to lend 800 financial institutions 529.5 billion euros ($711 billion) through its longer-term refinancing operation. That was more than the 470 billion-euro median of 28 estimates in a Bloomberg survey. Portuguese notes gained as the ECB was seen to be buying the securities.

“What we saw after the first LTRO is likely to develop further, with yields falling, and it will be no surprise to see further support for Italian and Spanish bonds,” said Patrick Jacq, a senior fixed-income strategist at BNP Paribas SA in Paris. “Demand was relatively strong and far stronger than the demand we saw in December.”

German bunds slipped with U.S. Treasuries as Federal Reserve Chairman Ben S. Bernanke signaled the central bank may not expand stimulus.

The Italian two-year note yield fell 29 basis points, or 0.29 percentage point, to 2.15 percent at 4:30 p.m. London time after dropping to the least since Nov. 5, 2010. The 2.25 percent note due November 2013 gained 0.47, or 4.70 euros per 1,000-euro face amount, to 100.185. That’s the first time the price of the securities has climbed to more than 100 cents on the euro.

Spanish, Italian Spreads

Spain’s two-year notes advanced for a 10th consecutive day, with the yield dropping 13 basis points to 2.32 percent. France’s 2 percent security maturing in September 2013 gained for a fourth day, with the yield dropping five basis points to 0.56 percent, after being as low as 0.53 percent.

Volatility in Portuguese debt was the highest in euro-area markets, according to measures of 10-year bonds, two- and 10-year yield spreads and credit-default swaps. The two-year note yield slipped 10 basis points to 12.70 percent as the ECB bought the nation’s bonds, according to two people with knowledge of the transactions, who declined to be identified because the trades are confidential.

Italy’s government note yields have tumbled about 4 percentage points since the ECB announced its plan to offer unlimited loans for three years on Dec. 8. Banks took 489 billion euros in the first operation later that month.

Decline After LTRO

“An obvious use of LTRO funding is to purchase government bonds paying higher rates,” Fitch Ratings said in an e-mailed report yesterday. “Sovereign spreads showed a marked decline following the LTRO” in December, it said.

The extra yield, or spread, that investors get for holding Italian 10-year bonds instead of similar-maturity German debt securities dropped three basis points to 3.52 percentage points. The spread between bunds and French bonds narrowed to 1.07 percentage points from 1.13 percentage points yesterday.

Demand for the safest securities waned as Bernanke said today in prepared testimony to the House Financial Services Committee in Washington that current policy “is consistent with promoting” the central bank’s objectives on jobs and inflation. He didn’t discuss options for further easing.

The Treasury 10-year note yield rose three basis points to 1.98 percent. Germany’s 10-year bond yield rose one basis point to 1.81 percent.

Union Investment

Italian bonds returned 10 percent in 2012 and added 4.1 percent profit this month, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Spanish securities have gained 2.6 percent this year, and German bonds rose 0.3 percent, the indexes show.

Germany’s Union Investment said it’s buying Italian and Spanish bonds because the liquidity measures from the ECB makes them attractive.

“We’re actively exposed to Spain and Italy,” Frank Engels, a Frankfurt-based managing director of fixed income, said in a Feb. 24 telephone interview. Engels’ 46-member team manages about 74 billion euros. “We like the idea that liquidity and reform measures should lead to further stabilization.”

Germany’s 10-year bund yields increased from as low as 1.78 percent yesterday, the least since Jan. 31. It also rose as a report showed the nation’s unemployment rate stayed at the lowest in more than two decades last month.

Europe’s largest economy sold 3.26 billion euros of 2022 debt securities today.

The 2 percent bonds were priced to yield an average 1.83 percent, attracting bids equivalent to 1.4 times the amount allotted. The so-called bid-to-cover ratio was unchanged from an auction on Feb. 1, when the country offered 4.1 billion euros of the debt. Total bids dropped to 4.69 billion euros from 5.68 billion euros.

The auctions “went smoothly, overshadowed by the outcome of the ECB’s three-year LTRO injection,” Annalisa Piazza, a fixed-income analyst at Newedge Group in London, wrote in a client note.

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